Court Schedules February Hearing in Suit Over CDTFA’s Refusal to Issue Refund Ordered by the OTA

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With a February 9 hearing scheduled by the Sacramento County Superior Court in a taxpayer’s suit challenging the California Department of Tax and Fee Administration’s refusal to provide a tax refund ordered by the Office of Tax Appeals, the CDTFA recently filed a cross-complaint asking the court to compel a reaudit.

The case is being watched closely by taxpayers, as there is concern that a win by the CDTFA would embolden the agency to ignore the OTA’s orders.

Starbuzz International, an Orange County-based company that makes flavored shisha for hookahs, filed suit in August demanding that the CDTFA abide by the OTA’s order to refund the company more than $2.8 million in overpaid taxes.

Two different panels of OTA administrative law judges concluded that Starbuzz is entitled to the refund. The first panel decided the case on the merits and ordered the refund. The decision hinged on a review of the tobacco content of Starbuzz’s product, shisha, which contains molasses, flavorings, and tobacco. (The shisha sold by Starbuzz International Inc. and Starbuzz Tobacco Inc. contains 16 percent tobacco; the former California statute imposed a tax on products that contain more than 50 percent tobacco. The law was changed in 2017 to include shisha and other products made wholly or in part of tobacco, regardless of tobacco content, but the change was prospective and did not include the prior periods at issue in the appeal.)

The second OTA panel granted the CDTFA’s petition for rehearing on grounds that it disagreed with the first panel’s legal reasoning. Starbuzz argued that the OTA exceeded the scope of its authority in granting the rehearing, and the company sued the OTA and the CDTFA to block the rehearing.

After the parties settled the litigation, a third OTA panel agreed with Starbuzz, holding that the petition for rehearing was granted improperly. The third OTA panel reinstated the original opinion and again ordered the CDTFA to pay Starbuzz the refund. The order became final April 14, roughly 7½ years after the company filed its initial refund claim.

“CDTFA’s actions denying appellants’ claims for refund are reversed, and appellants’ claims for refund are granted in full,” the OTA wrote in the third opinion.

The CDTFA has refused to issue the refund. Rather, the agency said it intended to conduct a reaudit of Starbuzz after the OTA closed the case, raising new issues – relating to tax reimbursement – that the agency failed to raise during the lengthy administrative dispute.

Responding to the taxpayer’s suit, the CDTFA filed a cross-complaint in which it argued that Starbuzz could obtain a “windfall” if the tax-reimbursement issue is not audited.

Starbuzz’s attorney, Marty Dakessian, wrote in a December 8 brief opposing the cross-complaint:

“The doctrine of res judicata blocks the CDTFA from re-auditing Starbuzz’s refund claims on any issue not raised during the administrative proceedings, including the issue of tax reimbursement. … This seven-and-one-half-year process provided the CDTFA with every conceivable opportunity to raise any and all issues, defenses, and legal theories available to it in opposing Starbuzz’s refund claim. … [The CDTFA] filed five separate briefs before three different OTA panels, and it presented extensive oral argument at two separate OTA hearings. … The January 2021 hearing lasted one hour and 11 minutes. The January 2023 hearing lasted two hours and four minutes. Thus, the Department cannot credibly argue that it did not have a full and fair opportunity to present its case and all questions relating to the refund claim and the Periods at Issue. The CDTFA never disputed the issue of tax reimbursement at the OTA (or even before that). It never disputed that the refunds belonged to someone other than Starbuzz. Consequently, res judicata blocks the CDTFA from now re-auditing Starbuzz on any issue that would reduce the amount of the refund granted by the OTA, including the issue of tax reimbursement.”

Dakessian added that the CDTFA “is careful to state that it has attempted to ‘process’ the refund claims, rather than state that it has effectively and impermissibly denied them a second time.”

“This presumably reflects the CDTFA’s understanding that it cannot deny refund claims already granted by the OTA or deny a refund claim twice,” Dakessian continued. “The CDTFA thus acknowledges, albeit implicitly, that it presently has no authority to deny Starbuzz’s refund claims for the Periods at Issue. This is correct. But suppose that: (1) the CDTFA is permitted to re-audit Starbuzz’s refund claims on the issue of tax reimbursement; (2) the CDTFA determines that Starbuzz collected tax reimbursement from its customers; and (3) the CDTFA therefore refuses to issue Starbuzz a refund. The CDTFA would say this is merely a consequence of ‘processing’ the refund claims. But this leaves Starbuzz without a legal remedy. Starbuzz would have no right to appeal the CDTFA’s ‘processing’ of the claims because the right to appeal to the CDTFA Appeals Bureau and the OTA are triggered by denials of the refund claims. … The OTA has no jurisdiction to hear a second appeal concerning refund claims it has already granted, but which the CDTFA is refusing to pay.”

The February 9 hearing will be held before Judge James Arguellas. Pursuant to local court rules, the judge will issue a tentative ruling on the merits of the matter by 2 p.m. the day before the hearing.